Letter agreements and side letters – when to use?

An agreement does not necessarily need to be embodied in the traditional structure of a contract (i.e. with a parties block, recitals, words of agreement, numbered articles and sections, and signature formula). Whilst the back of a cigar box may suffice, also a letter does. When would professional parties decide to reflect their agreement in such form? And if there is a contract, why do they use a ‘side letter’ alongside the contract? That’s what this blog post is about.

Most types of agreements are equally enforceable when they take the form of a letter from one party to the other (and ‘accepted’ or ‘agreed to’ by the other). A letter agreement is a letter that contains the terms of the agreement and is signed by the sender and by the addressee. Usually, a letter agreement is used for short agreements (although there are lengthy exceptions).

Side letters. In the context of an M&A transaction, letter agreements are sometimes referred to as side letters. They are agreed in connection with a set of transaction documents. Occasionally, when an acquisition agreement is not conveniently suited to address an arrangement amongst the parties, side letters are used. A side letter would address one subject; a transaction may therefore involve several side letters.
Side letters often address a subject matter that is of a highly sensitive nature and not intended to circulate amongst all persons who are involved in the preparation or execution of the transaction. In the context of an M&A transaction, side letters could address pension arrangements or an agreement between the parties as regards the possible remedies they are willing to accept when submitting the transaction for approval by competition authorities (where including such agreement in the body of an acquisition agreement may inadvertently trigger the competition authority to demand such remedy). This may be a letter of intent where the nature of the business is ill suited for inclusion in the body of an SPA. Also other sensitive aspects, such as a specific indemnity for embarrassing claims, can be a reason to prepare a side letter. In many jurisdictions, the disclosures against warranties are made in the form of a letter (which would nevertheless be attached to the acquisition agreement despite its sensible nature).

M&A and works council involvement. In the Netherlands, it appears to have become appropriate to sign a letter agreement to which all transaction documents (including the SPA) would be attached. The background of this is that under the Dutch Works Council Act, the parties are (in effect) prohibited from entering into a binding agreement before obtaining the advice of the competent works council, even if the SPA is conditional upon receipt of such advice. Obviously, obtaining the works council’s advice is, in many cases, highly undesirable considering the dynamics of the transaction and the turbulence that involving the works council could potentially trigger. In such case, the letter agreement prevents one of the SPA parties, which have typically concluded heavy negotiations, from taking advantage of the existence of the not-yet-signed SPA to renegotiate certain terms once the other party has formally requested the advice and made public announcements. Whilst such letter agreement is not entirely consistent with the spirit of the Works Council Act, for major transactions it is probably an optimal solution to adapt to the international M&A practice.

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